Why Income Inequality Went Missing in the 2012 Campaign

Nov. 5 (Bloomberg) -- Why did inequality never become the
defining issue of the 2012 campaign? It appears that voters,
intuitively, don’t see it as the problem some politicians would
have us believe.

Even economists disagree over how bad inequality is, the
correct way to measure it, why it’s increasing and what to do
about it. And most Americans, no matter how humble their
circumstances, don’t resent the wealthy so much as strive to get
rich, too. One point on which economists do seem to agree is
that income inequality by itself isn’t harmful -- except when
it’s so great that the scales of opportunity tilt. On that
score, the U.S. has reason to worry.

Median household income is lower than it was a decade ago.
At the same time, the gap between rich and poor has widened.
Economists recently reported that the top 1 percent receive
about a fifth of the national income -- up from less than a 10th
in 1970 -- and control about a third of the country’s wealth.

The data, however, overstate inequality by not counting
government transfers such as food stamps, unemployment insurance
and Social Security. When these things are included, every
income group shows modest gains from 1997 to 2007. When health
benefits are also calculated, income disparity really drops off,
with the bottom 20 percent registering income growth of about 26
percent. The top 5 percent show a 63 percent increase.

Inequality Mythology

Overlooking such benefits helps build the myth that
inequality is always bad. Yet some imbalance is good. Imagine a
tax system that would redistribute income so that everyone came
out roughly equal. Entrepreneurs wouldn’t be motivated to
innovate because they wouldn’t be able to reap the rewards.
Fewer risks would be taken, and economic growth would stall.

It would be convenient to blame the super-rich for stagnant
middle-class incomes. It would also be wrong. Technology and
globalization have done more than anything to toss workers out
of jobs and damp wage growth. Just because a 28-year-old tech
entrepreneur has billions doesn’t mean others have less. There
are fewer good-paying jobs because today’s growth industries are
creating enormous wealth, but not enormous numbers of jobs. The
payroll of a company like Facebook Inc. looks anemic next to the
industrial behemoths of yesteryear.

None of this is to say inequality ought to be ignored. Left
alone, it could erode opportunity, which ultimately would weaken
the economy. What matters is that the poor and middle classes
have pathways to advance. This is difficult under a system of
taxation, education and politics that favors the well-to-do.

What do we mean? Well, a tech entrepreneur, for instance,
can borrow against shares in his company without paying the
capital gains taxes that would be due if he sold stock. With the
right legal advice, his heirs don’t need to pay taxes either.

And the children of that entrepreneur are likely to do
better in school than their less-privileged counterparts thanks
to tutors and well-financed school districts. Indeed, recent
studies show that, since the late 1980s, the gap in test scores
between low-income and affluent children has widened by about a
third. College attendance is also declining because tuition is
rising faster than wages, and student loans are getting harder
to come by. Yet a college degree is the surest path to upward
mobility.

Here’s another discomfiting data point: Generational
mobility -- how often poor children move into the upper or
middle classes -- is now lower in the U.S. than in some European
countries. The Pew Economic Mobility Project recently found that
a child born in the bottom 20 percent has only a 17 percent
chance of making it to the upper-middle class. Forty-two percent
of boys born into the bottom 20 percent stay there.

Rebalancing Opportunity

Where does this leave us? If income inequality by itself
isn’t bad, and if it’s not a zero-sum game, it’s debatable
whether the tax system should be used to close the rich-poor
chasm. Redistributing income might choke off growth. But with
the opportunity gap growing, the tax code certainly shouldn’t
encourage more inequality, as it now does. In that spirit, here
are three tax and education reforms that might help rebalance
the opportunity scales:

The estate tax is a good starting point. For 2012, estates
get a $5.1 million federal exemption; amounts above that are
taxed at 35 percent. That overly generous treatment swings too
far in the other direction in 2013, when the exemption plummets
to $1 million and assets above that are taxed at 55 percent. We
prefer the in-between rates -- a $3.5 million exemption and a 45
percent tax on the remainder -- that existed until 2009.

As we’ve written, it also makes sense to limit the
countless deductions, exemptions and credits that benefit mostly
well-to-do taxpayers and cost the U.S. more than $1 trillion a
year in revenue. Economic research shows the two biggest tax
expenditures -- the mortgage interest deduction and the
employer-provided health-care exclusion -- may even hurt low-wage earners by driving up home prices and health-care costs.

Restricting these breaks would help make the tax code more
progressive without redistributing income by raising rates. It
would also free money for deficit reduction. President Barack
Obama, his Republican challenger Mitt Romney and bipartisan
deficit reduction panels, including the Simpson-Bowles
commission, have all embraced a form of this solution.

Another idea catching on with lawmakers in both parties is
education savings accounts, which work like 401(k) retirement
plans. The federal government would seed an account with $1,000
for every U.S.-born child, and parents could add as much as
$1,000 a year tax-free. Lower-income parents would get an annual
government contribution or matching amount. The money could be
used only for education expenses, including tutors. The cost --
about $4 billion a year -- would be worth it if more low-income
students graduated from high school ready for college.

Government’s proper role isn’t to guarantee everyone a
comfy suburban bungalow. Government can and should address
inequality, but with the goal of making sure the economic pie
grows enough that everyone’s living standards improve, even if
the top 1 percent get a bigger share.